Larry McMillans Market Commentary

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Anonymous said...

What is your opinion about this can you find reasons why this prima bear is wrong?

Stephen Roach (New York)

The United States continues to struggle mightily with globalization. China bashing is on the rise in Washington once again, even as the national unemployment rate falls below 5%. There is a political firestorm over a proposed acquisition by Dubai Ports World of a UK operator of five East Coast container terminals in the United States. This backlash and the protectionist debate it has spawned reflect the dangerous mixture of macro and politics. America’s saving shortfall has triggered a classic political blame game. Ever-complacent financial markets could care less.

Notwithstanding the understandable concerns over matters of national security in a post 9/11 world, there is a very simple and extremely powerful macro point that is being overlooked in this debate: America no longer has the internal wherewithal to fund the rapid growth of its economy. Suffering from the greatest domestic saving shortfall in modern history, the US is increasingly dependent on surplus foreign saving to fill the void. The net national saving rate -- the combined saving of individuals, businesses, and the government sector after adjusting for depreciation -- fell into negative territory to the tune of -1.3% of national income in late 2005. That means America doesn’t save enough even to cover the replacement of its worn-out capital stock. This is a first for the US in the modern post-World War II era -- and I believe a first for any hegemonic power over a much longer sweep of world history.

Faced with a shortfall of domestic saving, countries basically have two choices -- to curtail economic growth or borrow from the rest of the world. The first option just doesn’t cut it in the land of abundance. America, in general, and its consumers, in particular, treat rapid economic growth as an entitlement. That leaves the US with little choice other than to pursue the second option -- drawing heavily on the pool of surplus global saving as the means to fund economic growth. Once the US started consuming beyond its means, it left itself beholden to external funding and production. And that’s how China and Dubai have entered America’s macro equation.

That underscores a key attribute of the saving-short, deficit nation: It has no choice other than to run current account deficits in order to attract the requisite foreign capital. And in the case of the United States, where external funding needs are so massive -- now closing in on $800 billion per year -- most of the current account imbalance shows up in the form of a huge trade deficit. In 2005, for example, the trade deficit in goods and services accounted for fully 93% of the total current-account gap.

With that external funding imperative comes key geopolitical tradeoffs. Thank to China, America actually got a rather extraordinary deal for its trade deficit dollar in 2005 -- a net balance of some $200 billion of low-cost, high-quality Chinese goods that expanded the purchasing power of US consumers. If, however, Washington politicians now choose to close down trade with China by imposing high tariffs or forcing a major Chinese currency revaluation -- precisely the tact of a bipartisan coalition headed up by Senators Schumer (D-NY) and Graham (R-SC) -- those actions could well backfire. Absent the China supply line, the trade deficit for a saving-short US economy wouldn’t shrink as the politicians seem to imply. Instead, due to America’s outsize external funding needs, the trade deficit would remain large and merely gravitate to a higher-cost producer -- imposing the functional equivalent of a tax on the American consumer. Similarly, if Washington were to kill the bid by Dubai Ports World, another source of capital inflows would be required to fill the external funding gap. But maybe the next investor would ask for tougher financing terms.

The current political boil raises a critical question: Can the United States select its lenders and dictate the terms of its external financing program? The simple answer to the first part of the question is, “yes” -- targeted protectionism can, indeed, redirect the sources of external commerce. Through tariffs a la Schumer-Graham, or non-tariff restrictions on Dubai-based investors, the US could attempt to shift the mix of its trade and capital inflows. Such actions would do nothing, however, to address the basic problem. America’s trade deficit and concomitant capital surplus will simply shift elsewhere in the world. As long as the US economy is locked on a subpar domestic saving path, it is hooked increasingly on the “kindness of strangers” to provide the sustenance of its economic growth -- both in terms of capital as well as goods.

There’s an even darker side to the recent outbreak of protectionist backlash in the US -- the crass politics of scapegoatting. It’s not hard to figure out why. It stems from the ongoing angst of middle-class American workers -- an undercurrent of discontent that has not been tempered by a sub-5% unemployment rate. A US labor market that was once trapped in a jobless recovery is now mired in a wageless recovery -- an extraordinary stagnation of real wages even in the face of strong productivity growth. At the same time, the US is suffering from a record trade deficit, whose largest bilateral piece is with China. Bingo -- the politicians are quick to point the finger at China as being responsible for the trade-related pressures bearing down on beleaguered US workers.

But who is really to blame in all this? At the end of the day, America’s saving shortfall -- the origin of destabilizing capital and trade flows -- is a by-product of conscious choices made by the US body politic. The Federal budget deficit, which has accounted for the bulk of the plunge in national saving over the past six years, is made in Washington -- not in Beijing. The negative personal saving rate is an outgrowth of pro-consumption tax policies -- again made in Washington. US politicians are the source of resistance to tax reforms, such as a consumption tax, that might address the deficiencies of private saving. Of course, politicians never want to admit that they are the problem. Instead, they prefer to pin the blame on others -- in this case, China and Dubai.

Washington needs to be very careful what it wishes for. In effect, the UAE is being told that it is fine to re-cycle its petro-dollars into Treasuries -- just don’t buy American ports. China is getting the same message -- curtail your exports to the US but don’t dare stop gobbling up dollar-based financial assets. Meanwhile, the United States does next to nothing to address the macro root of the problem -- a staggering shortfall of domestic saving. The longer the US avoids the heavy lifting of fixing its saving shortfall, the greater the risks that America’s current-account funding problem will end in tears. In the end, the answer to the question posed above is “no” -- the US cannot carefully select its lenders as well as dictate the terms of its massive external financing program. The harder the protectionist push, the greater the risks of a financial market backlash that hits the dollar and US real interest rates.

24/2/06 10:31 AM  

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